Fed Liquidity Proposal Seen Trading Safety for Costlier Credit

“The proposed rule would, for the first time in the United States, put in place a quantitative liquidity requirement that would foster a more resilient and safer financial system,” Fed Chairman Ben Bernanke said before the vote. Photographer: Pete Marovich/Bloomberg

Oct. 25 (Bloomberg) -- A proposal to make U.S. banks
maintain 30-day war chests in case of a credit crisis is certain
to add to borrowing costs, said a former leader of the global
group that conceived of the standard.

Stefan Walter, who was secretary general of the Basel
Committee on Banking Supervision when it approved an initial
version of yesterday’s Federal Reserve proposal, said U.S.
regulators have continued their tough interpretations of Basel
III rules.

“Nothing is free,” said Walter, now a principal at Ernst
& Young LLP, in an interview. “Buying more resilience in normal
and good times means that liquidity will be priced-in more than
before, and that will have a certain degree of impact on the
cost of credit. That’s the obvious trade-off.”

The Fed proposal -- to be matched by other U.S. banking
regulators -- would require the biggest banks to hold 30 days of
easy-to-sell assets to make them safer in the event of another
credit crisis like the one in 2008. The plan would meet
international liquidity accords while forcing a much shorter
timeline than non-U.S. banks will face and narrowing what U.S.
banks can include among their assets.

The Fed plan is most stringent for banks with more than
$250 billion in assets or substantial international reach and
seeks implementation by 2017, two years ahead of the Basel
deadline.

$200 Billion Short

“The proposed rule would, for the first time in the United
States, put in place a quantitative liquidity requirement that
would foster a more resilient and safer financial system,” said
Fed Chairman Ben Bernanke. The proposal would require setting
aside about $2 trillion, and the Fed estimates U.S. banks are
currently $200 billion short.

The Basel Committee on Banking Supervision in January
agreed on a liquidity coverage ratio meant to ensure banks can
survive a credit squeeze without the kind of government aid
needed after the 2008 credit crisis.

That standard would let lenders go beyond cash and low-risk
sovereign debt to include some equities and corporate debt,
according to the agreement. The U.S. version would permit a
limited amount of government-sponsored enterprise debt while
excluding private-label mortgage-backed securities.

Liquidity’s Cost

“Even if they can meet the requirements, that’s not the
end of the story, because liquidity has a cost to it,” said
Robert Maxant, a managing partner at Deloitte & Touche LLP.
“That cost is reduced margins and lowered returns.”

He said another point of the proposal -- that firms with
more than $10 billion in foreign exposure are subject to it --
will target foreign-based banks with big U.S. footprints.

In the proposal, opened for 90 days of public comment,
banks can use an unlimited amount of cash, Treasuries and
central-bank reserves to fulfill the requirement and can also
keep 40 percent of it in less liquid assets. Those other assets
can include sovereign debt with a 20 percent risk weight and
debt from Fannie Mae and Freddie Mac -- subject to a 15 percent
haircut. A narrower 15 percent of the liquidity can be in
investment-grade corporate debt and publicly traded company
stock, with a 50 percent haircut.

Tougher Measurement

Yesterday’s proposal is also tougher than Basel when
determining the outflow of cash in a crisis -- calling for a
bank to figure its most costly day in the 30-day period rather
than using the 30th day, according to the staff memo to the
board.

Banks with more than $50 billion in assets and under the
$250 billion threshold would be subject to a more limited
version of the liquidity rule, requiring a 21-day minimum of
liquid assets on hand.

“This rule would help ensure that the liquidity positions
of our banking firms do not weaken as memories of the crisis
fade,” said Fed Governor Daniel Tarullo. The proposal, which he
said represents a regulatory breakthrough, is “more stringent
in a few areas” -- making it “super-equivalent” to Basel.

“I call it ’super-sized’,” said Karen Shaw Petrou,
managing partner of Washington-based research firm Federal
Financial Analytics Inc., in an e-mail. “That is, as in so many
other regulatory areas, the U.S. will be the toughest cop on the
beat regardless of the impact this has on cross-border harmony
or the competitiveness of the very largest U.S. banks.”

Basel Committee

Financial rules on everything from capital to liquidity are
set at the global level by the Basel committee, a group of
central bankers and regulators from 28 nations including the
U.S., U.K. and China. The liquidity coverage ratio was at the
center of an international tussle last year, as some central
bankers and regulators warned that a draft version of the
standard risked causing a credit crunch, while others urged
against a wholesale watering down of the measure.

“This move by the U.S. highlights the different emphasis
on either side of the Atlantic about the best way to underpin
financial stability,” Richard Reid, a research fellow for
finance and regulation at the University of Dundee in Scotland,
said in an e-mail. “It serves as a reminder that there are
limits to regulatory convergence given the underlying
differences in financial structure and economic circumstances.”

In previous measures to satisfy Basel committee accords,
U.S. regulators have also been tougher than the international
body. For example, the leverage limits for eight of the largest
U.S. banks proposed by the agencies in July as much as doubled
the 3 percent set in Basel as the minimum capital the banks,
including JPMorgan and Bank of America, must hold against their
assets.

Funding Ratio

Another related rule would create a yearlong funding
requirement is still under construction in Basel. That so-called
net stable funding ratio, initially approved by the Basel
committee in 2010, will be matched by a consistent proposal in
the U.S., Tarullo said.

The latest Fed proposal -- one of several liquidity and
capital rules the industry is still bracing for -- raises the
floor under an industry still flush with post-crisis cash
reserves, said Walter, who left the Basel committee in 2011.

“It’s like buying insurance,” he said. “You’ve got to
pay a premium for it.”